Free Market System Isn't Always Favorable

Nov 22, 2010

A few months ago, I commented in this column that packer margins and producer prices have become positively related in recent years. That contrasts with pre-2000, when the two values were clearly negatively related – high packer margins were associated with low hog prices. I still think the positive relationship is a good thing, but the past six weeks has seen the reemergence of the negative relationship, and that has caused some conflicts for pork producers.

I’m looking forward to today’s deadline for submitting comments on GIPSA’s proposed rules that will have major impacts on livestock and poultry production and marketing practices. Many (and I think most) pork producers have fallen on the “Stay out of our markets and let us work this out!” side. Some of those same producers, however, have complained that packers are just making too much money at a time when producers are hurting.

Sorry, but you can’t have it both ways. Winston Churchill, apparently quoting an unknown author, once famously quipped, “It has been said that democracy is the worst form of government except for all the others that have been tried from time to time.” So it is, I think, with free markets. They don’t always treat us the way we like, or the way we think we deserve, but they are better than the alternatives.

Packer Profits, Producer Losses The hog and pork markets this fall have indeed provided an opportunity for profits for packers. By-product values have bumped $20/head virtually all year and meat margins have spent the vast majority of the year above $10/head and several weeks this fall at over $20/head. Both have been near record highs (See Figure 1).

Those $20/head meat margins have drawn the particular attention of pork producers, primarily because they have coincided with a $23/cwt carcass decline in negotiated net (ie. spot market) prices and a $16/cwt carcass decline in the weighted average net price across all purchase methods (Figures 2 and 3). Both of those price series appear to have bottomed out and turned upward the past two weeks, but there is a reason for the dramatic declines: Producers kept bringing a lot of hogs!!

Hogs on Steroids Before you start firing off e-mails that begin with “Steve, you idiot …” or worse, please read on. I know that producers had no choice in the short run. Nine-month old corn and hot weather usually back up pigs in the summer. Fresh corn and cool weather cause them to hurry to market in the fall. Add in the fact that October has no holidays and you get seasonally-huge supplies in the fourth quarter. Hardly ever fails. Mother Nature is tough to fool. But the “piling up” effect of hog supplies has been on steroids in 2010. Nine-month old corn that started out lousy and got worse and pretty normal hot weather backed up a few hogs. Much better corn and near-perfect fall temperatures then began pulling them ahead. We have shipped an average of 2.33 million-plus head of hogs for five weeks now, when the September Hogs and Pigs Report said we should have averaged 2.24 million (Figure 4). And even at that marketing clip, the average weight of top barrows and gilts went up 6 pounds! Producers were shipping them as fast as they could!

Numbers Mount Up The .09 million head-per-week difference between expected and actual slaughter doesn’t sound like much. But it is 90,000 hogs per week or 4% of expected weekly slaughter. Further, 2.33 million/week is almost precisely the number that current capacity can handle in 5.4 days. My experience tells me that 5.4 days per week is the “sweet spot” for the U.S. packing sector – few enough to keep overtime and Saturday operations at reasonably sustainable levels and big enough that packers will not chase supplies. Per-unit costs are very likely near optimum levels of capacity utilization. Life is good – if you are a packer.

That’s not so if you are a producer and this year, of course, includes higher feed costs at a time when many expected them to trend lower. Producers just can’t win – right now. The beauty of markets that are allowed to function is that they change. Hog supplies will eventually decline. Packers who are now rather complacent because of near-optimal throughput will have to bid hog prices higher. Producer revenue will improve. Meat margins will fall. The world will be fairer. Until the next time it is not.

And what if that does not happen and packer margins remain wide? Someone will enter the packing business or expand their current level of operations. It has been proven possible. Entry into pork packing is not cheap nor easy, but it can be done and will be done again should these margin levels and low hog prices persist.